MEXICAN PARTICIPATION IN THE MAQUILADORA INDUSTRY: LOAN THEM THE MONEY!!!

By David W. Eaton.

National Law Center for Inter-American Free Trade

Centro JURICI

Increasing Mexican participation in the expanding maquiladora industry and the lucrative maquila suppliers market is a top priority of President Ernesto Zedillo. The maquila industry has been one of the primary motors fueling Mexico's economic recovery. Maquilas play four fundamental roles in the Mexican economy: creation of jobs, generation of hard currencies to pay Mexico's dollar-based international obligations, transfer of technology, and a redistribution of political and economic power to the border states. Nevertheless, Mexican investors and suppliers of raw materials and intermediate goods are not sharing in the benefits of this profitable sector. The Maquiladora Decree of October 1996 promotes the development of "sub-maquilas," which are essentially Mexican-owned subcontractors for established maquilas. The hope is to increase the "value added" services provided by Mexican-owned companies. Annually, maquilas purchase over $4 billion of raw materials and intermediate goods for use in their plants in Mexico. The vast majority of these inputs are purchased from U.S. or Asian suppliers. Several Mexican companies have the expertise to serve as alternative suppliers. Increased Mexican participation in the maquila and suppliers industries would be advantageous for Mexico and, in the long run, beneficial for U.S. businesses. Unfortunately, this article will establish that Mexican companies will not be able to participate in the growing maquila industry unless Mexico substantially reforms its lending laws.

Cheap and accessible credit is the engine driving economic expansion in all developed economies. The inability under Mexican law to create and enforce security interests in most personal property effectively prevents small and mid-size businesses from obtaining credit to finance new sub-maquilas and suppliers in Mexico. NAFTA allows U.S. and Canadian banks to participate in lending transactions in Mexico with the hope that foreign banks would infuse much needed capital to finance economic growth in Mexico. However, when personal property is located in Mexico, Mexican secured-lending laws control all efforts by U.S. banks to exercise their rights over the collateral. Mexican law will control even under situations where the parent company of the maquila is American, the loan is payable in U.S. dollars, and all other aspects of the transaction are controlled by U.S. law. Thus, U.S. lenders are constantly rejecting otherwise viable requests for loans from Mexican companies due to the banks’ inability to create security interests in assets located in Mexico. Without significant reforms, Mexico will find itself severely disadvantaged with respect to its NAFTA partners, who have more reliable lending laws and access to capital.

In Mexico, start-up monies for business are loaned on the basis of long-standing familiar or personal relationships and not on the objective credit worthiness of the borrower. As a result, access to capital from lending institutions has only been available to the privileged few who are part Mexico’s political and industrial elite. These practices have developed a system in which lenders have placed little importance on security-interests in personal property. Thus, there has been no need for Mexican lending laws to evolve to allow for the use of reliable public registry systems or personal property (assets) as collateral.

Mexico’s Use of Possessory Security Interests

The National Law Center for Inter-American Free Trade (NLCIFT) has prepared a comparison of U.S. and Mexican lending practices which illustrates the antiquated nature of Mexico’s asset-based lending laws. According to Todd Nelson, principle author of the study, an asset-based transaction designed to provide financial support for a U.S. manufacturer would likely include a fixed-term loan amortized over a specified number of years. The transaction would more than likely include a renewable, revolving line of credit. The line of credit is often secured by all assets the manufacturer currently owns or subsequently acquires through the use of a single security agreement. Under the security agreement, the purchase of any new inventory, equipment, or creation of accounts receivable are added to the list of collateral which may be used to satisfy obligations owed to the lender.

Under normal circumstances, in the United States, lenders protect themselves by filing a financing statement in the Secretary of State’s office in the state where the manufacturing facility is located. Before the filing of the simple one-page financing statement, a lender will carry out a lien search in the office of the Secretary of State in order to ensure that there are no unknown creditors asserting an interest in the collateral. U.S. law allows the parties to file an extremely broad description of the collateral, which includes all current and subsequently acquired assets. Broad collateral descriptions give the lender guarantees that a wide array of assets can be used to satisfy the obligation and provide the borrower with a broad spectrum of personal property they can offer as collateral. The security agreement can also be structured in such a way that, in the event the loans are ever increased, all of the debt will automatically be secured by the original collateral with priority as to other creditors relating back to the original filing date.

In stark contrast, Mexican secured lending laws favor actual physical possession of collateral, especially real estate, over asset-based lending mechanisms that permit the use of property such as inventory. Mexican possessory security interests involve the retention of the collateral's invoice or relinquishment of the good to insure repayment. For example, a lender traditionally keeps possession of the borrower’s invoice until full payment has been tendered. Invoice retention is used frequently when a bank wishes to keep a security interest in equipment, which is particularly damaging for Mexican sub-maquilas and suppliers as equipment is one of the most important assets they have to offer as collateral. Invoice retention was designed to prevent the debtor from pledging the same equipment to various creditors. While the invoice is in the possession of the first creditor, subsequent creditors contemplating the acceptance of the same collateral as security and who have conducted a search in all reasonable filing locations would not learn of any competing interests. If the borrower should receive a second loan secured through already leveraged equipment, the second lender has no rights to the leveraged asset because the law favors the party in possession of the invoice.

In the event the borrower defaults on the loan, the party who performed a title search and properly filed would be unprotected under Mexican law against the lending institution who retained possession of the invoice. Banks are aware of the inadequacies of the Mexican filing system and of the practice of invoice retention. As a result, banks often insist on taking physical possession of the debtor's collateral, which is frequently in the form of inventory. While actual physical possession of collateral is quite effective at combating fraud, it is an overly restrictive restraint of trade and hinders the development of Mexico’s export industry. Handing over physical possession of assets as collateral is disastrous for a sub-maquila or suppliers in need of short term financing because it forces the plant to relinquish possession of parts and components needed to fabricate goods called for under existing contracts.

Mexico’s Filing System

Mexico's filing system exacerbates the problems of creating a security interest. Identifying competing prior claims to assets offered as collateral is very difficult in Mexico. Almost without exception, a U.S. lender will perform a lien search in the corresponding filing office to ensure that there are no competing prior claims to the offered collateral. The usefulness of a lien search is contingent on the reliability of government record keeping systems. Fortunately, most U.S filing offices are easily accessible and maintain reliable information. In contrast, most Mexican filing systems are far below U.S. standards and create barriers to flexible and agile lending institutions. If lenders cannot quickly and cost-effectively determine their relative priority over third parties, they will simply look for more secure markets in which to loan their money. The most prohibitive aspect of the Mexican filing system is the daunting task of identifying the proper office in which to file and search for competing interests. Mexican regulations outlining the filing process are confusing and difficult to interpret. Consequently, security interests are often improperly filed and subsequent searches do not identify competing interest holders. As a general rule, banks do not lend money if they do not have minimum levels of certainty regarding their relative priority over collateral. Thus, the inadequacies of Mexican filing systems creates substantial barriers for small and mid-size companies in need of start-up credit.

Asset Based Lending- Facilitating Economic Growth

Asset-based lending reform is a necessary first step to increasing Mexican participation in the maquila industry. Asset-based lending is a system in which loans are secured by personal property instead of real property. Successful asset-based lending requires stringent underwriting policies, a comprehensive understanding of the collateral, and a strict system for collateral monitoring. This form of lending is very common in the United States and most developed economies. In contrast, Mexican law has not evolved to utilize such lending practices. In Mexico, it is difficult to create a security interest in equipment, inventory and accounts receivable held by a sub-maquila or supplier. Mexican rules on collateral are highly dependent on the use of real property and have hindered manufacturers’ ability to use personal property such as inventory and equipment to obtain loans.

Lending institutions provide resources which allow good market ideas to turn into viable business ventures. To ensure repayment of loans, lending institutions insist on guarantees from the borrower, usually in the form of collateral. Before banks will accept collateral they require proof that the same collateral has not been offered to another lending institution. This is accomplished in the United States through the use of reliable public registry systems that provide for a quick, inexpensive and reliable means of establishing priority over collateral between banks. The U.S. lending system has developed in such a fashion that borrowers have tremendous flexibility in the collateral they can offer, and banks are granted the security they need to ensure that collateral offered by the debtor has not been pledged to another lending institution. Unfortunately, Mexican banking laws do not offer the legal certainty and protection demanded by banks needed to give them the confidence to lend money to small start-up companies.

Creditors in the United States have unique rights which protect them in the event the debtor/manufacturer does not comply with the lending agreement. Often, when a manufacturer defaults on a loan in the United States, the bank may seize the collateral without court intervention. It should be noted that such non-judicial remedies are only available in the absence of the debtor’s objection. If an objection to the non-judicial seizure of the collateral is manifested, most states provide for expeditious pre-judgment remedies. Another attractive benefit afforded to U.S. secured creditors is their ability to collect the debtor’s outstanding accounts receivable to satisfy the loan without judicial intervention. A simple notification by the secured creditor to the account debtor instructing them to remit payment directly to the bank is all that is required. The above protections have given lenders in the United States the security to readily grant credit for viable economic ventures.

The effectiveness of a security interest is a factor of how quickly and inexpensively a creditor can enforce it. The problem with security interests in Mexico is that they are not expeditious in the procurement of collateral to remunerate a debt. Mexican lending laws do not allow creditors to confiscate the collateral and sell it to satisfy the debt without a lengthy judicial preceding. Unnecessary delays create two significant risks which dissuade banks from loaning to Mexican companies. First, delays give the debtor time to move assets out of the creditor’s reach. Second, during the course of a lengthy judicial process to exercise against collateral, assets can depreciate in value. In the United States, the use of non-judicial remedies such as the right of self-help or pre-judgment provisional remedies, allow the creditor to take control of the collateral and sell it to satisfy the loan while waiting for the court’s final ruling. Non-judicial remedies such as those used in the United States are illegal under Mexican law. This is yet another barrier to Mexican participation in the Maquila industry.

Mexican law has traditionally been distrustful of flexible, expeditious and non-judicial mechanisms to exercise against collateral or to create security interests. Mexican law does not provide for the use of a single legal mechanism to create a security interest in inventory, equipment, and accounts receivable. Lenders and borrowers must find their way through the labyrinth of mechanisms exist that must be used to create an enforceable security interest in Mexico. It is often difficult to determine which legal document one must use to create a binding security agreement. For example, in order to finance a given project, a sub-maquila may be forced to use several of Mexico’s varying security devices, which include pledges, installment sales contracts, and chattel mortgages or trusts. Each of these devices has its own system of filing and standards for granting priority interests against other creditors. The use of so many instruments for one single project makes filing very costly and creates uncertainty. All of these factors have contributed to U.S. banks’ hesitation to lend money in Mexico.

U.S. asset-based lenders are particularly concerned about their inability to use after-acquired-property clauses in Mexico. An after-acquired-property clause allows a U.S. creditor to maintain priority over other creditors for any assets acquired by the debtor after the signing of the lending agreement. Such a clause is an absolute necessity for any secured transaction in the United States. Currently, a U.S. bank wanting to extend credit to a sub-maquila would have to enter into and record a new security agreement or an amendment to the original agreement every time replacement inventory was acquired or new accounts receivable were generated by the Mexican company. Logically, such a cumbersome system is not commercially viable.

One of the most valuable assets held by a sub-maquila or supplier is its inventory. Maquilas often have large quantities of intermediate goods that are to be incorporated into the manufacturing process, as well as final products awaiting exportation to the United States. However, these companies have great difficulty using inventory to secure loans. The need for a detailed description of collateral under Mexican law virtually destroys a sub-maquila or supplier's ability to use fluctuating stocks of inventory as collateral. To provide adequate security and priority for the lender, the Mexican security agreement must describe the collateral with minute detail. On the other hand, U.S. law permits a lender to describe collateral very broadly. As a result, U.S. manufacturers often use inventory to secure loans to finance different points in the production cycle. It is important to note that U.S. law would recognize a description as broad as "all inventory," while in Mexico the same description would be considered invalid and leave the lender unprotected against third parties.

A revolving line of credit often provides a U.S. manufacturer with the flexibility to meet the demands of a changing marketplace. In contrast, Mexican law disdains such fluctuating indebtedness. An American revolving line of credit allows the debtor’s obligation to fluctuate without affecting the validity of the underlying security agreement. In the United States, the validity of a security interest is not tied to the existence of a specific amount of debt. Therefore, the quantity of the debtor’s obligations to the bank are permitted to vary, dependent upon market demands. A security interest is deemed an accessory to the underlying debt, according to the Mexican lending laws. Therefore, Mexican law requires that the original security agreement specify the exact amount of the loan, which must subsequently be paid down to zero before any new monies may be lent. Once the balance reaches zero, the original security interest must be canceled and, if the debtor needs more money, the parties must file a new security agreement. Such repetitive filings are costly, time-consuming and may cause a lender to lose priority vis-à-vis intermittent third party lenders. In turn, U.S. asset-based lenders are further reluctant to provide Mexican companies with revolving lines of credit necessary to respond to today’s ever-changing global marketplace.

In order to facilitate Mexican participation in the profitable export market, a new center has been formed in Tijuana. The Centro de Proveedores y Negocios para la Industria Mexicana de Exportación will serve as a central clearing house for Mexican, American, Asian and European companies interested in participating in Mexico's growing export market. Similar centers have played important roles in the development of thriving export economies in Japan and Taiwan. Interested companies should contact the projects director, Carlos de Orduña, in his San Diego office at 619-661-1134.

Conclusion

In summary, six major reforms must be undertaken to facilitate the proper investment climate in which U.S. lenders contribute much needed start-up money for Mexican sub-maquilas and supplies. First, a single security agreement which can be expeditiously, inexpensively and securely filed must be developed. A single security agreement would lower costs associated with filing and provide certainty for lenders searching for competing interests. Second, Mexico’s over-dependence on real property must be changed so that Mexican sub-maquilas and suppliers can use accounts receivable in the United States and Mexico as collateral. Third, modern flexible devices that allow personal property such as machinery and inventory to be used as collateral must be developed. Fourth, reforms must be instituted to permit the use of revolving lines of credit. Fifth, the Mexican system must move away from its over-dependence on physical possession of collateral by creating a more reliable filing system. Finally, non-judicial procedures must be instituted to allow creditors to promptly exercise against collateral before it is moved or depreciates in value.

David W. Eaton is a trade consultant with Centro JURICI in Monterrey, Mexico and a legal researcher for the National Law Center for Inter-American Free Trade.

A similar version of this article appeared in Business Mexico.

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